What Is Breaking the Buck?
Breaking the buck occurs when thenet asset value (NAV)of amoney market fundfalls below $1. Breaking thebuckmay happen when the money market fund'sinvestment incomedoes not coveroperating expensesor investment losses. This normally occurs when interest rates drop to very low levels, or the fund uses leverage to createcapital riskin otherwise risk-free instruments.
When breaking the buck occurs, it doesn't bode well for investors. Shares are valued at $1 but end up dipping below that price means investors may lose part of the principal value on their investments.
Key Takeaways
- Breaking the buck occurs when thenet asset value of amoney market fundfalls below $1.
- This may happen when the money market fund'sinvestment incomedoes not coveroperating expensesor investment losses.
- Breaking the buck generally signals economic distress because money market funds are considered to be nearly risk-free.
Understanding Breaking the Buck
The NAV of a money market fund normally stays constant at $1. This is facilitated by market regulations. Market regulations allow a fund to value its investments at amortized cost rather than market value. This gives the fund a constant $1 value and helps investors identify it as an alternative to checking and savings accounts. So if the fund has two million shares, their combined value would be $2 million. By using an amortized pricing structure, the fund can manage its own activities and provide for redemptions.
When the value of the fund goes below $1, however, it's said to break the buck. Even though this is a rare occurrence, it can happen. Breaking the buck generally signals economic distress because money market funds are considered to be nearly risk-free. Investors often use money market funds in addition to checkable deposit accounts as additional sources of liquid savings. These funds are like open-end mutual funds that invest in short-term debt securities such as U.S. Treasury bills and commercial paper. They offer a higher rate of return than standard-interest checking and savings accounts. But they are not insured by the Federal Deposit Insurance Corporation (FDIC).
Most money market funds have check-writing capabilities and also allow money to be easily transferred to a bank account. Money market funds pay regular interest that can be reinvested in the fund.
Breaking the buck normally occurs when interest rates drop to very low levels, or the fund uses leverage to createcapital risk.
Money Market Fund History
Money market funds were first introduced in the 1970s. They are used to help to make investors more aware of the benefits of mutual funds, which helped significantly increase asset flows and increase demand for mutual funds. The first money market mutual fund was named the Reserve Fund and established the standard $1 NAV.
The first case of a money market fund breaking the buck occurred in 1994, when Community Bankers U.S. Government Money Market Fund was liquidated at 96 cents because of large losses in derivatives.
In 2008, the Reserve Fund was affected by the bankruptcy of Lehman Brothers and the subsequent financial crisis. The Reserve Fund’s price fell below $1 due to assets held with Lehman Brothers. Investors fled the fund and caused panic for money market mutual funds in general.
Following the 2008 financial crisis, the government responded with new Rule 2a-7 legislation supporting money market funds. Rule 2a-7 instituted numerous provisions, making money market funds much safer than before. Money market funds can no longer have an average dollar-weighted portfolio maturity exceeding 60 days. They also now have limitations on asset investments. Money market funds must restrict their holdings to investments that have more conservative maturities as well as credit ratings.
Money Market Fund Investing
Vanguard is a leader in money market fund products. It offers two taxable money market funds and three municipal funds all priced at $1. Its best-performing money market fund is the Vanguard Federal Money Market Fund (VMFXX). It had a year-to-date return of 0.67% as of September 30, 2022. Investors have received a return of 3.88% from the fund since its inception in July 1981.
The fund has roughly 139 holdings with an average maturity of 60 days or less. Its net assets were $214 billion, with a management expense ratio of 0.11%. The Vanguard Federal Money Market Fund requires a minimum investment of $3,000. According to its fund profile, it's the most conservative of the Vanguard funds.
Why Does Breaking the Buck Happen?
Typically, breaking the buck happens because the money market fund's investment income fails to cover its operatingcosts or investment losses. But it can also be a response to a broader economic issue, such as a unusually low interest rates amid an economic recession.
Does Breaking the Buck Happen Often?
No, breaking the buck is not a frequent occurrence, with money market funds generally seen as some of the safest, most reliable investments available.
What Are Vanguard's Money Market Mutual Funds?
There are two taxable funds — the Federal Money Market Fund (VMFXX) and the Treasury Money Market Fund (VUSXX). There arealso three municipal funds — California Municipal Money Market Fund (VCTXX), Municipal Money Market Fund (VMSXX), and New York Municipal Money Market Fund (VYFXX).
